Intermediate Maturity Bonds Hit the Curve's Sweet Spot

Record-low long-term municipal bond yields may generate the most press these days, but investors still see the most value in the intermediate part of the yield curve.

Bonds that mature between roughly seven and 18 years lie in the sweet spot for investors, muni analysts say.

Those maturities offer the best prospects for returns and will suffer the least if interest rates rise. So far this year issuers have come to market with the bulk of volume targeted to that portion of the yield curve for refundings, according to analysts at Citi and Bank of America Merrill Lynch.

The muni bond group at JPMorgan favors the belly of the curve relative to the long end, in terms of the optimal spot in which to invest, says Peter DeGroot, muni strategist at the firm.

“From the standpoint of yield and roll-down return,” he said, “we believe that the intermediate sector of the curve, specifically in nine years and then again in 12 and 14 years, that the projected total return in a flat interest-rate environment would be stronger in those areas of the curve relative to the absolute long end of the curve, or 30 years.”

For investors who are compelled to add yield by moving out further on the curve, DeGroot added, there is little value to moving out past 25 years.

Muni analysts at Citi mostly agreed. In a recent research report, they wrote that some of the best values on new issues are in the 12-to-18-year range.

The slope of the triple-A general obligation yield curve of maturities from one to 30 years flattened throughout April, according to numbers from Citi investment research and analysis. The slope measured 321 on March 30 and 299 on May 3.

During that period, the largest drop in yields occurred between credits that mature in seven and 20 years. Their declines measure between 24 and 27 basis points over the month.

The 30-year triple-A yield dropped to a record low 3.09% on Tuesday, Municipal Market Data numbers revealed. And muni ratios to Treasuries there have gotten richer over the past 30 days, falling four percentage points to just under 102%.

But ratios appear even richer on the long end, John Hallacy, muni analyst at Bank of America Merrill Lynch, wrote in a report. B of A determined a fair-value measure for triple-A-rated munis by using the relationship among triple-A muni ratios, Treasury rates and corporate bond spreads.

They looked at the actual 30-year muni ratio to Treasuries against the predicted fair-value ratio implied by the model. Then they compared the actual versus the predicted for the 10-year muni ratio.

“With the 30-year ratio at 102.5% versus fair value of 107.8%, and the 10-year ratio at 96.1% versus fair value of 97.4%, the 10-year currently appears to offer better relative value,” Hallacy wrote.

A big reason behind their findings, he added, most likely stems from the fact that a large amount of refundings packed a higher proportionate amount of supply in intermediate maturities rather than those at the long end.

“In the current environment,” Hallacy says, “the 7-to-9-year and the 15-to-18-year parts of the curve may offer the best value.”